Bangalore/Mumbai: India’s capital markets regulator has given conditional approval for United Spirits Ltd’s (USL’s) stake sale to Diageo Plc and an open offer to public shareholders by the UK-based distiller, bringing the deal a step closer to fruition.

The Securities and Exchange Board of India (Sebi) made its approval of the 11,170 crore deal subject to the two companies dropping a key clause in the sale agreement.

Under the clause, if Diageo is unable to gain a majority stake in USL after the open offer, Vijay Mallya’s United Breweries Holdings Ltd (UBHL) would turn over a part of or its entire remaining stake and voting rights in USL to Diageo for a four-year period.

Regulatory approvals of the deal signed in November would potentially pave the way for an infusion of much-needed cash into the debt-laden UB Group. The stake sale is yet to win approval from the antitrust watchdog, the Competition Commission of India (CCI).

According to the Sebi website, the regulator on 31 January sent its “final observations" on a proposed open offer by Diageo to public shareholders.

The so-called final observations essentially mean a regulatory clearance, but Sebi’s approval is subject to the removal of the clause, a person with direct knowledge of the matter said on Tuesday.

“Sebi has cleared (the takeover), but they have to remove the clause which is in nature of forward contract and violates Securities Contract Regulations," the person cited above said.

Diageo, the world’s largest liquor company, agreed to acquire 53.4% of USL. It agreed to purchase a 27.4% stake in USL, including 19.3% from Mallya, for £660 million (around 5,545 crore today), and fresh equity from the firm.

The British distiller agreed to follow up the purchase with an open offer to buy 26% of USL from public shareholders at 1,440 per share—the price paid for the direct purchase.

Before the open offer, Diageo will likely own 27.4% of USL after buying the stake from Mallya’s UBHL and fresh shares, the issue of which has been approved by USL’s shareholders. UBHL is expected to own 14.9% of USL’s current share capital after the stake sale.

Diageo was originally scheduled to start the open offer on 7 January, but it was postponed as both Sebi and CCI had asked the companies for more information related to the transaction.

A Business Standard newspaper report last month cited an unnamed Sebi official as saying that the regulator was worried about a clause that gives Diageo the right to withdraw from an open offer if the offer price is revised up. Sebi has the option of asking it to raise the offer price.

However, the person cited above said Sebi had allowed the firms to retain this clause.

A UB Group executive, who declined to be identified, confirmed that Sebi had given the critical clearances.

“This go-ahead means a lot to the UB Group as money will start flowing in," a UB Group executive said on Tuesday. “Promoters can indirectly infuse money in troubled and grounded subsidiary Kingfisher Airlines. The biggest hurdle is approval from the Competition Commission of India, but we expect that to happen shortly."

However, it was not immediately clear whether Diageo would proceed with the open offer even if CCI approves the deal.

“I can confirm that we have received an observation letter from Sebi, which is part of the ongoing approval process. We are now considering Sebi’s comments. We have nothing further to add," Rowan Pearman, a Diageo spokeswoman, said in an email from London.

A Sebi spokesperson declined to elaborate on the contents of the regulator’s observations.

In January, Mint reported that CCI had asked for more details on the USL-Diageo deal.

A CCI official, who declined to be identified, said on Tuesday that the firms had not yet submitted the details and clarifications that CCI had sought.

“CCI’s approval is independent of Sebi’s. We will take a call once they give the clarifications," the official said.

Senior USL executives are to meet CCI officials this weekend to provide clarification on points raised by the regulator, UB executives familiar with the development said.

The deal with Diageo is crucial to Mallya and his UB Group, which had debt of 22,999.11 crore as of 31 March 2012, according to Mint research.

Though Mallya has not publicly said so, he is expected to use at least some of the proceeds of the Diageo deal towards debt repayment and equity infusion in his grounded Kingfisher Airlines.

USL would receive 3,300 crore, which will be used to reduce its debt of more than 8,000 crore, and Mallya’s holding company will get 2,400 crore from Diageo, money that can be used to get Kingfisher flying again.

The airline, which has liabilities of more than $2.5 billion (around 13,325 crore today), lost its operating licence in late 2012 and hasn’t paid salaries for several months.

USL reported strong earnings on Monday, with net profit jumping 71% to 80.6 crore for the December quarter, helped by cost control and higher-than-expected volume growth. On Tuesday, the company’s shares rose 2.11% to 1,894.95 on a day the BSE’s benchmark Sensex fell 0.46% to 19,659.82 points.